Perceiving Uncertainty on Financial Markets During the Covid-19 Pandemic

• Název práce v češtině: Vnímání nejistoty na finančních trzích během pandemie Covid-19
• Název v anglickém jazyce: Perceiving Uncertainty on Financial Markets During the Covid-19 Pandemic
• Klíčová slova anglicky: uncertainty, financial markets, Covid-19 Pandemic
• Akademický rok vypsání: 2020/2021
• Typ práce: bakalářská práce
• Jazyk práce: angličtina
• Ústav: Institut ekonomických studií (23-IES)
• Vedoucí / školitel: PhDr. František Čech, Ph.D.
• Řešitel: skrytý - zadáno vedoucím/školitelem
• Datum přihlášení: 29.09.2021
• Datum zadání: 29.09.2021
• Datum a čas obhajoby: 07.06.2022 09:00
• Místo konání obhajoby: Opletalova - Opletalova 26, O105, Opletalova - místn. č. 105
• Datum odevzdání elektronické podoby: 03.05.2022
• Datum proběhlé obhajoby: 07.06.2022
• Oponenti: Mgr. Martin Hronec

Seznam odborné literatury

Irwin, R. D. (1991). Banking Terminology, 3rd edition. American Bankers Association.

Chippindale, L., & Nishimura, M. (2002). Forward rate agreement notional principal contract or forward contract Journal of Taxation of Financial Products.

Nicula I., & Bucur, C. R. (2012). Economic insights – trends and challenges. Some Theoretical and Practical Uses of Forward/Futures Rate Agreements. https://doi.org/10.51865/eitc

McConnell, P. (2013). Systemic operational risk: the LIBOR manipulation scandal. Journal of Operational Risk.

Shiller, R. J. (2019). Narrative economics: How stories go viral et drive major economic events. Princeton University Press.

Serna, M. I. M., & Navarro, E. (2015). Interest Rate Volatility and Business Cycle Expectations. International Finance

Předběžná náplň práce v anglickém jazyce

Research question and motivation
The main research question is how did the perception of uncertainty change on the financial markets due to Covid-19. In March 2020, there was a significant drop in the global financial market. However, the financial market recovered relatively quickly and even continued rising above the pre-Covid values, even though the Covid-19 positive cases were increasing and the global situation was becoming worse. I find these trends surprising and I would like to find out if and how the incoming data about Covid-19 influenced the uncertainty on financial markets.

To capture the uncertainty I decided to look at interest rate derivatives such as Forward Rate Agreement (FRA). It is defined as a contract “between two parties wishing to protect themselves against a future movement in interest rates“. (Irwin,1991) It can also be used for speculative purposes, to take a position on movements in interest rates. (Lisa Chippindale, Miki Níishimura,2002) Hence, it describes the consensus opinion about the future of a financial situation in a specific country. FRAs are usually based on LIBOR (London Interbank Offered Rate). Determining such a rate includes a process that may result in a conflict of interests and unethical behaviour. (McConnell,2013) Hence, FRAs bear a systematic operational risk and could be affected by human error. Trading FRAs is an important investment activity for both market makers (the opportunity to profit from the buying and selling transactions spread) and also end-users (to hedge against risk associated with interest rate movements).(Ileana Nicula, Crina Raluca Bucur,2012).

I will study the effects of the pandemic statistics, such as new daily cases, the number of deaths, new economic restrictions from governments, announcements from international institutions, etc., on the volatility of various interest rate derivates in specific countries. Even though Covid-19 is a global problem I expect various countries to react differently, based on local perceiving of the pandemic and the government’s attitude towards it. Moreover, I assume that various behavioural biases and heuristics play a significant role in perceiving the uncertainty due to Covid-19 resulting in non-rational decisions and reactions to new data. To capture possible irrational decisions I will look at the velocity and magnitude of the reaction on incoming data about the pandemic. As John Maynard Keynes argued in his General Theory of Employment, Interest and Money, “animal spirits”- representing a “spontaneous urge to action instead of inaction”- are drivers of the economy. (Shiller,2019)

Contribution
Existing research proposes various ways how to utilize Forward Rate Agreement. For example, if an investor needs a loan and expects an increase in interest rates in the near future, he might use Forward Rate Agreement (FRA) in order to save higher costs due to higher interest rates. Moreover, there can be found a negative relationship between interest rate volatility and expectations regarding the business cycle. Volatility tends to increase during harsh times of uncertainty. (Serna, Navarro, 2015) However, the research is very limited in terms of looking at the volatility of FRA and its implications, especially during times of the current pandemic. Moreover, by looking at the concrete and recent time frame there is an opportunity to find various relationships in the financial markets reactions to incoming data and to better understand behaviour of economic agents.

Methodology
I will use freely available financial market data from the internet and Covid-19 related statistics in various countries. Moreover, I will incorporate significant monetary policies from authorities, such as quantitative easing, that have an impact on the volatility of FRA, in order to describe the key factors determining FRA rates. By comparing the volatility of FRA with the incoming data about COVID-19 statistics I will be able to look for various relationships among them and possibly draw conclusions about the behaviour of economic agents. I will also use standard time-series techniques such as (vector) autoregressive moving average and (multivariate) autoregressive conditional heteroscedasticity models to capture dynamics of FRA in individual countries and to analyze possible dependencies among them.

Outline
Introduction
1) What makes my topic appealing?
2) Overview of existing knowledge
3) My augmentation to existing research
4) Organization
Literature review and hypotheses
1) Literature on forward rate agreement
2) Evidence of effects of the Covid-19 Pandemic on the volatility of FRA
3) What hypothesis will be tested
4) Motivation and reason of the hypotheses
Methodological Approach
1) Description of data and methods used
2) My execution of the analysis
Empirical Results
1) Interpretation of results
2) Discussion of results
Conclusion